Sunday, March 04, 2012
7:28:30 PM EDT

Trade Ideas when Resistance 'Becomes' later Support

by
Leigh Stevens

A common chart pattern is seen when resistance is pierced and subsequent pullbacks find support in the same area. The same is true in reverse, where support 'becomes' later resistance and this applies to trendlines also.

I'll get into this in a moment but first to my mailbag and a note about ways, if any, to determine (bullish/bearish) sentiment in other markets like commodities or Forex (Foreign Exchange).

SUBSCRIBER QUESTION:

"i'm an avid follower of your articles and wondered if you could tell me what you use to guage sentiment in both the forex and commodity markets? i use the put/call ratio in stocks."

I could never get the same up to date sense or 'reading' on bullish/bearish sentiment with either Forex or the commodities markets. I followed the Foreign Exchange market closely in years spent working in London when I managed Dow Jones TradeStation in Europe. Our biggest customer's for our sophisticated systems trading software and going to a large number of bank FX traders, was because so many traded 'technically'; e.g., on chart patterns, indicators, momentum, etc. Across multiple languages and time zones of the 22 hour a day Forex market, charts 'spoke' a common language.

Because Forex trades quite 'technically' I found I could rely on the charts more than is sometimes the case with stocks and stock indexes.

There are commodity futures surveys of sentiment where they poll traders, etc. but these things are not timely or as accurate as what we have with options daily volume numbers.

Futures also have Open Interest (OI) figures. Rising or falling OI relative to prices can provide certain trading inputs but it's not equal to sentiment readings with the Market. With Commodity Futures you can assess a certain degree of bullishness or bearishness by the spread between cash prices and the futures market; e.g., when futures become quite 'rich' to cash, it can suggest 'excessive' bullishness and spec buying more than commercial/trade activity for hedging, etc..

RESISTANCE 'BECOMING' LATER SUPPORT and Vice-Versa:

SUPPORT BECOMING LATER RESISTANCE

It's often the case that when a stock or stock index pierces or 'breaks out' above a significant prior high(s), a subsequent pullback to this same price area will find buying coming in; i.e., it finds support.

You don't have to look that far to find examples in the stocks. I usually start with the 30 stocks in the Dow or other key bellwether stocks in the Nasdaq. Before I've looked at a half dozen such charts, there are examples of this such as seen with Boeing (BA) during the time period shown on its weekly chart.

Painting this picture with a bit more of a BROAD brushstroke, IBM, which is in a powerful move (a powerhouse of a company per much of its history!)IBM was finding resistance in the 120-130 area. A sharp pullback followed, where the stock lost around 38% of its value, suggesting this (120-130) price zone as a very key resistance.

Once IBM again went above 130, it wasn't all up, up and away from there as you can see on the chart. However, it's also apparent that buying interest (support) was being found now in the 120-130 zone in a reversal of the significance of this price area. Prior resistance 'became' subsequent support. This over many weeks, but the weekly trend is the most telling in assessing individual stock trends. Once assessed and time for action, zero in the daily and hourly charts for trade timing purposes.

The same concept of prior resistance once pierced, 'becoming later support applies to the major market indexes as well. We see that clearly in my next chart, that of the weekly Nasdaq 100 (NDX) Index.

WHY this dynamic? Prior sellers, at what had been resistance, now see this same area as a chance to re-establish long positions in the index in the same price area where they sold previously. Given a renewed uptrend, this means not having to chase prices higher; they can become active buyers in these situations.

"KISS-OF-DEATH" TRENDLINES

Just as a prior price support area, once pierced, can become resistance later on, a support/up trendline can play the same role.

Trendlines, once pierced don't 'go away' so to speak, as extending out the same trendline continue to represent the former rate of climb or upside momentum. Once that 'momentum' is broken by the trendline being pierced as seen with the RUT weekly chart below, a return to that same rate of upside momentum makes for a key test of just how much buying is coming in on the upswing. Often, getting back to its prior rate of upside price change, as represented visually by the trendline, is the end point or 'exhaustion' of the move.

This is not to say that prices will collapse once they hit what I euphemistically call the "kiss of death" (KOD) trendline. However, this type reversal pattern often is a harbinger of at least an intermediate correction; e.g., intermediate term for me is 2-3 weeks and above. For example regarding intermediate-term corrections, when RUT broke below its up trendline in early-August, the decline lasted 10 weeks in time, but there wasn't a huge further price decline after the first 2 weeks of sharp selling. More below this chart on the 'KOD' term.

I picked up the kiss of death term and trendline concept from Michael Jenkins, whom I knew in New York Wall Street days as an independent trader. He was I observed, more brilliant as an analyst-type than a trader and they used to interview him some on CNBC. He talked about what he called the "Kiss of Death" trendline which is exactly what the pattern looks like above with the caveat that price can come back to the trendline again and again and it (the trendline) simply becomes a rising line of resistance. This happens less often when the index or stock is question is at an 'overbought' extreme.

Michael Jenkins learned quite a bit from a truly legendary technical analyst, George Lindsay, who was then the ONLY one such analyst (technical) employed by an institutional broker-dealer (Ernst & Co.). George Lindsay was an inspiration to my mentor, Mark Weinstein, a fabulously successful private trader. I talk about George Lindsay in pages 14-16 of my (Essential Technical Analysis) book.

The 'kiss-of-death' trendline term has stuck in my mind ever since. Such trendlines almost always define resistance even if it's a rising line of resistance rather than a downside reversal. I think we'll see further downside in the case of RUT as the daily chart (see my Index Wrap column from yesterday) also suggests an intermediate reversal pattern.

As the sun sets over the Pacific outside the windows of my study causing me temporary blindness, I'll sign off.